Seeking a Company’s Elusive Sales Data

Prominent Wall Street investors are arguing acrimoniously over whether the nutritional supplements company Herbalife is a pyramid scheme.

The company's fate, though, will ultimately be determined by ordinary people like Victor Aragundi, a taxi driver from Corona, Queens, who regularly visits a local Herbalife storefront to buy teas and protein shakes.

In many ways, the fight over Herbalife boils down to one question: How many Mr. Aragundis actually exist?

As regulators and investors scrutinize the company's sales, they face a major stumbling block. The public numbers do not provide a clear picture of who buys Herbalife products - and why.

So-called direct-sales companies like Herbalife operate in an accounting gray area that allows them to book goods bought by its network of sales representatives as revenue. Most traditional retailers record sales when a customer buys something.

The uncertainty has left shares of Herbalife vulnerable to wild swings in recent months. On Monday, the stock sank sharply in the morning over fears that the company faced new regulatory scrutiny, but it later shook off the early losses.

Investors are betting on the extremes: Herbalife is a pyramid scheme or it is not.

William A. Ackman, a hedge fund manager, has called the company an abusive pyramid scheme and said the stock was essentially worthless. He says repeat purchasers like Mr. Aragundi are not the main source of Herbalife's sales but rather sales recruits. If a significant number of the recruits fail to sell the goods, they can face large losses.

"Money from the millions of low- and middle-income people at the bottom of the pyramid is being transferred to the tiny fraction of distributors at the top of the pyramid," Mr. Ackman said in an interview. "It's Robin Hood in reverse."

The company has fought back, generating support from big investors like Daniel Loeb and Carl C. Icahn. Herbalife cites its long history of sales growth and its compensation plan, which it says focuses on product sales, not recruitment.

"Herbalife is a financially strong and successful company, having created meaningful value for shareholders, significant opportunities for distributors and positively impacted the lives and health of our consumers over our 32-year history," Barbara Henderson, a spokeswoman for the company, said in a statement.

But it is hard to discern the underlying demand. The company doesn't specify how many of those products are eventually sold to customers outside the sales network. Nor does it detail how many products are consumed by members of its network.

One saleswoman who left Herbalife in October said she saw little consumer demand. "They want to make people believe there is this long line of consumers," said Ana Arias, of Scottsdale, Ariz., who was part of Herbalife's network for three years before quitting. "I realized it was going to go nowhere." Ms. Arias, who is considering legal action against Herbalife, estimates her overall losses at $210,000.

Ms. Arias's name was mentioned in a consumer's complaint about Herbalife that was submitted to the Federal Trade Commission last year. The complaint was one of 188 released by the commission in response to a Freedom of Information Act request by The New York Post.

Frank Dorman, a spokesman for the F.T.C., declined to say whether the agency was investigating Herbalife. In a statement on Monday, the company said that except for "voluntary dialogue with regulators," it was "unaware of any other regulatory interest and/or investigation."

The enforcement division of the Securities and Exchange Commission has opened an investigation into Herbalife, according to a person briefed on the matter. Last year, the agency exchanged letters with Herbalife about its financial disclosures. In 2011, Herbalife stopped including data in its annual report about members' buying patterns, and the agency wanted to know why.

Some people in the Herbalife network say consistent consumption drives profit. Edgar Montalban, an Herbalife salesman who oversees the Queens location that Mr. Aragundi visits, says the store has monthly sales of $4,000 to $5,000. He declined to say what his personal income was from the store, as well as his earnings from sales recruits. "We promote daily consumption," he said through an Herbalife representative.

In theory, Herbalife could silence the critics by disclosing a crucial number in its financial statements: the percentage of sales outside its network. It would be hard to call the company a pyramid scheme if it disclosed that, say, 80 percent of its final sales were to customers, rather than new sales representatives.

Some industry executives have promoted the importance of this number. "The final litmus is, 'Who is the customer?' " Rick Goings, the chief executive of Tupperware Brands, said last week in an interview with CNBC.

More than 90 percent of Tupperware's sales are to people outside its network, he said. The remaining amount, he said, is to sales representatives who like the company's new products. Tupperware, however, does not include this number in its public financial disclosures.

Regulators also emphasize sales such figures.

The War Over Herbalife

What to make of the heated feud between Carl Icahn and hedge fund manager Bill Ackman over Herbalife, and whether there is money to be made in the world of finance anymore, with Barry Sternlicht, Starwood Capital Group.

Last week, the Federal Trade Commission, along with some state attorneys general, moved to shut down Fortune Hi-Tech Marketing, accusing it of being a pyramid scheme. The lawsuit noted that few of the products were ever sold to anyone outside the network.

Herbalife says it does not collect comprehensive data on sales to people outside its network. Herbalife does, however, require its sales representatives to keep records of their transactions.

To address the skepticism surrounding the company's external sales, Herbalife has provided two pieces of new data. The company said 31 percent of its orders in the United States were "directly shipped" to customers outside its network. It also produced a study by a consulting firm, Lieberman Research Worldwide, that found that 92 percent of Herbalife sales went to people outside the company's network.

The study was not based on Herbalife's actual sales data. Instead, Lieberman extrapolated from an Internet survey that the company had more than six million customers. Given the 480,000 Herbalife distributors in America, the firm estimated that only 8 percent of Herbalife products were consumed within that network.

Des Walsh, Herbalife's president, said the study validated the company's view that people in its sales network "are selling to millions of customers outside the distribution channel."

Defenders of Herbalife can point to the meager number of regulatory actions. In theory, an abusive pyramid scheme that produces scores of failed recruits should generate a steady stream of complaints.

That does not seem to be the case with Herbalife.

An official at the office of the attorney general of California said it had received no more than five complaints a year about Herbalife over the last eight years. And those complaints were mostly related to Herbalife's products, not its recruitment practices, said the official, who requested anonymity because he was not authorized to speak to the news media on this matter.

Still, pyramid schemes may not produce large numbers of complaints.

In its home state of Kentucky, Fortune Hi-Tech Marketing, which was accused of being a pyramid scheme, received only about a dozen official complaints since 2008, according to the office of the state attorney general. Allison Martin, a spokeswoman for the office, explained that victims of a pyramid were often embarrassed about revealing losses. Fortune Hi-Tech may also have focused on people who were not legal immigrants, which might have made them even less likely to report the scheme, Ms. Martin said.

On a recent winter morning, Herbalife customers in Queens brushed aside the controversy. Mr. Aragundi, the taxi driver, and others streamed into the store for their daily teas and shakes.

"Four years ago I took the product," said Mr. Aragundi. "I lost like 30 pounds."